Zwick Center for Food and Resource Policy Outreach Report No

Zwick Center for Food and Resource Policy Outreach Report No. 62

WINE GRAPE PRODUCTION IN CONNECTICUT: A FINANCIAL ANALYSIS

Gunnar W. Eubanks* Jeremy Jelliffe** Boris E. Bravo-Ureta***

January 2020

Charles J. Zwick Center for Food and Resource Policy Department of Agricultural and Resource Economics College of Agriculture and Natural Resources 1376 Storrs Road, Unit 4021 Storrs, CT 06269-4021 Phone: (860) 486-2836 Fax: (860) 486-1932 Contact: [email protected]

* Research Technician, Agricultural and Resource Economics (ARE), University of Connecticut (UConn), Storrs. ** Graduate Research Assistant, ARE, (UConn), Storrs. *** Professor, ARE, UConn. Corresponding author [email protected]

WINE GRAPE PRODUCTION IN CONNECTICUT: A FINANCIAL ANALYSIS

I. INTRODUCTION

Grape and wine production in Connecticut have increased significantly over the past two decades. In 2000, the State had 10 commercial wineries producing 375 tons of grapes on 145 acres (Albu Consulting, 2005). According to the last agricultural census, the number of commercial producers had risen to 78 operations cultivating 356 acres of grapes (NASS, 2017). And, in 2019, we had over 40 operating vineyard/wineries that participated in the CT Wine Passport program (this is not the total number of wineries in CT, just those participating in this program).

According to Connecticut General Statutes (Chapter 545, Section 30-1(e)(5)), licensed wineries are required to utilize at least 25% Connecticut grown grapes in their wines. In addition to this General Statute, there is a program and designation of Connecticut Grown, which requires wineries to use at least 51% CT grapes. To meet demand for their products, Connecticut wineries typically import grapes, grape juice, and concentrate from various locations including New York State and California (Albu Consulting, 2005). These imports suggest that expanding local grape production could make an important contribution to the growth and sustainability of the Connecticut wine industry.

The general objective of this report is to contribute to decision making by presenting a financial analysis for grape production in Connecticut using a representative farm model. The remainder of this report is organized into four sections. Section II explains the methodology used followed by the results in Section III. The report ends with a summary and conclusion in Section IV.

II. METHODOLOGY

This section presents the methodology used to develop our analysis. We first discus the characteristics of the representative vineyard used. This is followed by a brief discussion of the procedures applied to undertake the financial evaluation.

The Representative Farm

A representative farm model is developed based on information assembled from a variety of sources (Cesaro et al., 2008; French, 1977). The intention is to model a farm that is representative of the typical situation present in the industry and location under analysis. These types of models are useful in investigating a priori the impact of different assumptions, such as alternative technologies, yields, and prices (Herbst, 1996). Moreover, Köbrich et al. (2003) contend that the Representative Farm Model is a valuable tool for potential investors

1 and producers while acknowledging that every firm has its own set of unique features and challenges.

Our representative vineyard is constructed based on information gathered from the literature, including previous grape studies for Connecticut (e.g. Jelliffe, 2012; Jelliffe and Bravo-Ureta, 2013), statistical information from USDA censuses and surveys, and interviews with Connecticut grape producers. Below we present the specific characteristics and assumptions made and how the figures were derived, followed by a summary of the base case representative farm (see Table 1).

Base Case Assumptions

Farm Size: The representative farm has a total of 10 acres.

Grape Varieties: The analysis of the representative farm includes 9 varieties of grapes, chosen for their cold hardiness and common practice in Connecticut.

Grape Prices: The Base Case prices are set at an inflation-adjusted price based Jelliffe and Bravo-Ureta (2013). The Vinifera and Hybrid set price is $2,000 per ton, i.e., $1/lb., based on information from buyers at CT wineries.

It is also assumed that prices, in real terms (adjusted for inflation), remain constant over the 20-year life of the project analyzed in this study. The evidence shows that real grape prices experienced limited annual growth over the past 20 years. (NASS, U. 2019, ’17, ’12, ’07, ’02)

Yields: The yields used for each variety are taken from the information provided by Cornell’s Viticulture and Enology Extension Department and confirmed by field information from producers. Individual varietal yields can be found in Table 2.

Land and Values: We assume that the land is owned and remains as such throughout our 20- year planning horizon. The assumed rented rate for land is fixed at $200 per acre per year over the investment period.

Equipment: The new equipment cost information was obtained from established agricultural equipment suppliers (Table 3). The equipment set was generated based on the information provided by the farmers interviewed. Particular attention was given to the representative scale of operations for farms that strictly produce wine grapes. (Machinery Pete, 2017)

Labor: The estimated labor expense incorporates an unskilled worker at $13.50/hr. and a skilled worker at 17.00/hr. These wage rates are derived from the Bureau of Labor Statistics for Connecticut Agricultural workers and some adjustments are made from our field data.

Fertilizer: The cost of fertilizer is based on the average cost per acre provided by CT growers multiplied by the acres farmed.

2 Fixed Cash Outflows: This flow includes insurance, equipment storage, and taxes on all equipment, liability insurance, property taxes, and rent. The itemized list can be found in Table 3.

Financial Analysis

Three indicators are used to examine the financial viability of wine grape production for our representative farm: Net Present Value; Internal Rate of Return; and Payback Period (Boardman et al., 2006; Zerbe and Dively, 1994).

Net Present Value (NPV): The NPV is the difference between the present value (PV) of cash inflows and cash outflows, i.e., the PV of net benefits. When NPV is used correctly it consistently provides the right answer for the value of the project. The equation for NPV is as follows:

�� = = −I + (1 + �) (1 + �)

NBt is the Net Benefits of the project in time period t, I0 is the initial investment in time period zero, and r is the interest rate. The decision rule for NPV is as follows: NPV = 0, the investor would be indifferent; NPV > 0, invest; NPV < 0, do not invest.

Internal Rate of Return (IRR): The IRR is the interest rate at which the NPV equals zero. In other words, the IRR represents the discount rate where the PV of Benefits (B) equals the PV of Costs (C). The formula for the IRR is as follows:

� � �� ⇒ = (1 + ��) (1 + ��)

The decision rule for the IRR is as follows: IRR = rR, indifferent; IRR > rR, invest; IRR < rR, do not invest. The term rR is the required rate of return which is determined exogenously.

Payback Period (PP): The PP is the amount of time periods (usually years) that it would take to recover the initial investment. The PP is calculated as:

�� = �� ≥ 0

The decision rules for Payback Period are as follows: PP = PPD (Payback Period Desired), indifferent; PP < PPD, invest; PP > PPD, do not invest.

It is important to note that the impact of an investment or project needs to be analyzed by comparing the situation with and without such an investment, i.e., the opportunity cost. In other words, what is being analyzed is the incremental cash flow that can be attributed to

3 the project compared to a status quo case (i.e. without project). In this analysis, the without project situation assumes that owned land (10 acres) would be rented out at $200 an acre per year or $2000 total (Table 1). This value is selected based on the assumption that the rental value of land represents a good estimate of its agricultural use value. However, this value can vary significantly based on land quality and current use. Prospective growers must examine the opportunity cost of establishing a vineyard based on returns from current land use and expected net benefits, i.e., their own incremental value.

III. RESULTS

Below we first present the results of the base case scenario for the 10-acre representative grape farm based on the assumptions described above and summarized in Table 1. We then discuss the results of a sensitivity analysis on NPV, IRR, and PP.

The sensitivity analysis is performed by changing one assumption at a time and maintaining all others constant at the base case level (i.e., ceteris paribus). Sensitivity for the expected net returns from the project is examined under the following alternative assumptions: 1) Used equipment; 2) Farm size = 20 acres; 3) 10% decrease in yield; and 4) New York Prices. As we note below, the base case scenario generates attractive financial results; therefore, the sensitivity analysis focuses primarily on adverse assumptions.

The results of the sensitivity analysis are found in Table 5 and are reported at the farm level unless otherwise noted in the respective tables.

Base Case: The Base Case reveals an NPV of $101,366, at a 9% discount rate, for a per acre NPV of $10,137; an IRR of 15.3%; and a 12 year PP. The break-down of Base Case cashflows are contained in Table 4.

Scenario 1: Used equipment instead of new. This option decreases the startup cash outflows, which might be appealing for operators with limited financial resources or current farmers seeking alternative uses for their land and who already have the required equipment. The results here indicate: NPV = $16,221 per acre; IRR = 20.3%; and a nine year PP.

Scenario 2: Doubling Base Case farm size. The results indicate positive financial returns when acres are doubled resulting in: NPV = $19,527 per acre; IRR = 23.6%; and an eight year PP. Although this is presented at the total farm level, additions in acreage takes advantage of the economy of scale given that land purchase is not a factor.

Scenario 3: 10% Yield Reduction. Yield volatility is a common source of risk in farming and thus an important variable to include in the sensitivity analysis. The results here indicate that with a 10% yield reduction, the NPV (9% discount rate) drops to $4,628 on a per acre basis, or by $5,509 compared to the Base Case of $10,137. The IRR drops to 12.0% and the PP is 16 years. In the event that yields are lower across the life of the project, it still remains a viable investment.

Scenario 4: New York State (NYS) prices are used instead of Connecticut prices. The use of NYS prices for each variety of grapes that included in the analysis, leads a loss of $15,169 per acre (NPV); at a rate of -5.6% (IRR); and does not pay back over the 20 year investment horizon (PP) (NASS, 2018).

IV. SUMMARY AND CONCLUSIONS

The objective of this study was to examine the financial returns of a grape producing operation using a representative farm model. It serves as an update to prior studies of CT wine grape production (Bravo-Ureta, 1983; Jelliffe and Bravo-Ureta, 2013). For this study, we use various sources of information to update the current production costs and returns to generate a base case situation as well as several scenarios to examine the sensitivity of the financial results.

The analysis supports the conclusion that grape production, under conditions prevailing in Connecticut can be a viable financial undertaking. Future work on value added processing of wine and the establishment of vertically integrated farm vineyard wineries would provide a more complete picture of the industry and representative CT operations.

Studies have considered the positive economic impacts of the CT wine industry on the state economy, which has grown significantly over recent years (Heffley et al., 2010; Lopez et al., 2010, 2017). An examination of the economic impact of wineries on the CT economy found the industry generated between $145.0 to $154.2 million in sales benefits with direct industry sales making up $85.8 million, and between 635 to 978 CT jobs in 2015 (Lopez et al., 2017). Furthermore, industry growth has been highlighted with a 130% increase in sales benefits and 165% increase in CT jobs between 2007 and 2015 (Lopez et al., 2017). Under these current rates of industry expansion additional research on wine grape production is warranted as demand for CT grapes continues to increase. This study should be a useful resource to current and prospective growers seeking a basis of comparison for their operations.

5 Table 1. Itemized Base Case Assumptions for the Representative Farm Item Assumption Comments Prices $2,000/ton Vinifera Price are constant over project $2,000/ton Hybrid lifespan (20 years) Yields No production – Year 1-2 Drop fruit to increase plant vigor 65% of Potential – Year 3 Maturation period 100% of Potential –Year Yields remain constant 4+ Land 10 acres Rent $200 per acre Equipment, Purchased new Machinery, and Value of 2019 equipment Buildings Labor Unskilled $13.5/hr.

Skilled $17.0/hr. Variable Expenses Fuel, labor, fertilizer, Expenses are generally a function of maintenance, acreage, time, or reported amounts miscellaneous Fixed Expenses Insurance, taxes, rent

Table 2. Cash Inflow & Outflow Per Acre (100% Potential Yields – Yr. 4+) Net Cash Grape Yield/ Price/ Total Total Flow/ Acres Variety Acre Ton Inflow/Acre Outflow/Acre Acre Planted Cabernet Franc 2.65 2,000 5,300 3,351 1,949 1.12 Lemberger 3.42 2,000 6,840 3,351 3,489 1.11 Marechal Foch 5.00 2,000 10,000 3,351 6,649 1.11 Chardonnay 3.36 2,000 6,720 3,351 3,369 1.11 Pinot Gris 2.65 2,000 5,300 3,351 1,949 1.11 Traminette 2.94 2,000 5,880 3,351 2,529 1.11 Seyval 5.68 2,000 11,360 3,351 8,009 1.11 Cayuga White 4.95 2,000 9,900 3,351 6,549 1.11 Vidal Blanc 4.28 2,000 8,560 3,351 5,209 1.11

Total/Acre $ 3,350.8 $ 7,759.8 10

Table 3. Annual Outflows Farm Totals (10 Acres) Year 1 Year 2 Year 3 Year 4+

Operating Expenses Site Preparation 1,674 Vines and planting 6,890 Replanting and Rogueing 389 1,280 1,460 Dormant pruning & brush removal 540 1,700 4,390 Herbicide application 322 328 328 331 Fertilization 252 263 408 941 Canopy management 1,350 3,820 5,478 Disease and insect control 874 1,182 3,305 6,495 Take away and hilling up 471 1,741 1,520 1,450 Mowing 740 842 865 Total 10,484 6,533 13,203 21,410

Establishment Expenses Machinery 98,000 9,800 9,800 9,800 Trellis 39,510 988 988 Drainage 43,595 Total 141,595 49,310 10,788 10,788

Annual Fixed Expenses Taxes - Property 880 880 880 880 Insurance - Farm 430 430 430 430 Total 1,310 1,310 1,310 1,310

Cumulative Annual Farm Total $153,389 $57,153 $25,301 $33,508

7 Table 4. Net Cash Flows and Payback Period: Base Case Farm Totals With Project Without Project Cash Cash Cash Cash Incrementa Payback Year Inflow Outflow Inflow Outflow l Cash Flow Period 1 0 153,389 2,000 1,310 (154,079) (154,079) 2 0 57,153 2,000 1,310 (57,843) (202,765) 3 50,438 25,301 2,000 1,310 24,448 (183,887) 4 77,598 33,508 2,000 1,310 43,400 (153,141) 5 77,598 33,508 2,000 1,310 43,400 (124,934) 6 77,598 33,508 2,000 1,310 43,400 (99,056) 7 77,598 33,508 2,000 1,310 43,400 (75,315) 8 77,598 33,508 2,000 1,310 43,400 (53,534) 9 77,598 33,508 2,000 1,310 43,400 (33,552) *10 82,098 33,508 2,000 1,310 47,900 (13,318) **11 77,598 78,508 2,000 1,310 (1,600) (13,938) ***12 77,598 33,508 2,000 1,310 43,400 1,492 13 77,598 33,508 2,000 1,310 43,400 - 14 77,598 33,508 2,000 1,310 43,400 - 15 77,598 33,508 2,000 1,310 43,400 - 16 77,598 33,508 2,000 1,310 43,400 - 17 77,598 33,508 2,000 1,310 43,400 - 18 77,598 33,508 2,000 1,310 43,400 - 19 77,598 33,508 2,000 1,310 43,400 - 20 87,398 33,508 2,000 1,310 53,200 - Net Present Value @ 9% $101,366 Internal Rate of Return 15.3% Payback Period 12 years *Equipment is salvaged at year end **Equipment is purchased to replace old *** Payback period

Table 5. Sensitivity Analysis: All Cases on a Per Acre Basis NPV/Acre IRR PP Case Situation @ 9% % Years Base Case 10-acres $10,137 15.3 1 2 Scenario 1: Used Equipment $16,221 20.3 9 Equipment Type Scenario 2: 20-Acres $19,527 23.6 8 Farm Size Scenario 3: 10% Reduction $4,628 12.0 16 Lower Yields Scenario 4: New York State ($15,169) -5.6 20+ Lower Prices

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